30 The Milken Institute Review Expeditionary

Economics Make Entrepreneurs, Not War

by robert looney

The hearts and minds of the citizens of impoverished countries, we’ve been told time and again, can’t be won without filling their bellies. Yet nine years after the U.S. in- vasion of Iraq – and tens of billions in reconstruction aid later – Iraq’s GDP barely exceeds the prewar high. Worse, the remains almost wholly dependent on oil, which generates 90 percent of tax revenues and more than 80 percent of export revenues. Now, NATO is rapidly winding down its presence in Af- ghanistan. And the Afghan economy, which is almost to- tally dependent on foreign aid and crumbs from the U.S. military’s table (along with opium), is likely to go into a tailspin as donor countries recoil from Afghanistan’s in- competent governance and failure to contain pervasive Tcorruption. What is the point of spending trillions of dol- lars and hundreds of thousands of lives (American and Af- ghan) to secure a hostile country if the economic mess we leave is as bad as the one we inherited? What, indeed. Hence, the emergence of a new field in , dubbed “expeditionary economics” by Carl Schramm, the former head of the Kauffman Foundation. That concept focuses on the development side of the mili- tary equation. The gist is straightforward:

Second Quarter 2013 31 expeditionary economics cent in 2012. Underemployment is harder to is vital for stabilizing post-conflict and post- measure, but is almost certainly much higher. disaster settings, and the U.S. military, often Pretty much all job creation in the formal the dominant player in such environments, economy has been make-work in the public must sharpen its ability to encourage indige- sector. A shadow economy continues to em- nous entrepreneurship. It is Schramm’s con- ploy a large segment – perhaps 40 to 45 per- tention (and mine) that the conventional U.S. cent – of the labor force. As in other countries, approach in recent post-conflict recoveries though, it operates at low be- has failed largely because it has failed to focus cause it has little access to capital and cannot on precisely this objective. enforce contracts through legal means. The expeditionary economics approach is In the initial stages, the U.S. strategy for re- based on a pair of propositions. First, even in pairing the Iraqi economy after the fall of Sad- highly unstable settings, entrepreneurial ac- dam Hussein seemed promising. It was drawn tivity can flourish and provide , up along lines similar to the shock-therapy essential goods and financial stability for the transition programs successfully imple- local populations. Second, successful local en- mented in Chile under the Pinochet regime in trepreneurs, particularly those involved in the 1980s and in Poland after the overthrow of new firms, have a vested interest in improved Communism. In devising their strategy, Amer- governance – the rule of law and control of ican planners drew heavily on the conven- corruption. So, once they become established, tional wisdom in vogue in the early 1990s – entrepreneurs will lead efforts to achieve those neoliberalism as embedded in the standard goals. With these processes in play, Schramm Washington Consensus formula (macroeco- argues that sustained economic growth, and nomic stability, fiscal prudence and free mar- thus stability, can be attained in what were kets) – so often prescribed in times of crisis by previously considered impossible situations. the International Monetary Fund. And at least one case study, of the impact of the The cornerstone of the strategy was to cre- coffee industry in post-genocidal Rwanda, ate an independent central bank charged with suggests he’s right. maintaining stability that would be able to resist pressures to finance big government iraq, the morning after budget deficits. The primary goal (after stabili- Most of the core propositions of expeditionary zation) was to unleash the competitive forces economics can be traced to the U.S. experience suppressed by Saddam, thereby increasing in Iraq. Since the 2003 invasion, Iraq’s econ- productivity. As in post-Soviet settings, though, omy has floundered badly. Despite vast a secondary objective was to make the transi- amounts of assistance along with increasing tion irreversible – here, by destroying state- oil revenues, the country has been plagued by dominated Ba’athist institutions and replacing chronic unemployment – the government them with decentralized, -oriented claimed joblessness had fallen to “only” 16 per- ones. The Americans were convinced that a Chile-

Robert Looney is a professor of economics at the Naval like, competitive, noninflationary economy Postgraduate School in Monterey, Calif., and the author of would serve as the ideal environment for job a Kauffman Foundation study applying the concept of creation through private-sector innovation expeditionary economics to Pakistan. His views do not

necessarily reflect those of U.S. government agencies. and investment. Accordingly, almost all barri- sobhani reuters/omar previous page:

32 The Milken Institute Review ers to international trade were eliminated. (A skills – a dismayingly large group, since public 5 percent across-the-board tariff was allowed, education fell into decay under Saddam – or though largely as a revenue raiser.) And foreign capital for small businesses. The legacy pri- investment was welcomed, both as a means to vate-banking system, which was stuck holding supplement anemic Iraqi savings and to obtain Saddam’s bad debts, was on the verge of col- modern industrial technology. The only levy, lapse. And besides, the banks had little experi- apart from the import tariff, was a Steve ence in commercial lending. As a result, most Forbes-type 15 percent flat tax on consump- Iraqis were left out in the cold, fueling wide- tion. An $18 billion infrastructure program spread anger that was easily mobilized by ex- was focused on lowering private sector pro- tremist sectarian groups. duction costs. Job One for the Iraqi govern- In this violent, politically uncertain envi- ment was to keep out of the way. ronment, it proved impossible to attract the But the strategy was designed without private investment (domestic or foreign) on consulting Iraqis who knew anything about which the whole strategy depended. The result the economic culture. And, of course, Iraqi was a vicious circle of private sector underper- bureaucrats with practical experience in gov- formance and high unemployment – and little ernance – most of whom had lost their jobs hope of change, thanks to widespread, eco- because they’d been members of the Ba’athist nomically disruptive violence. Party – played no role in the early implemen- Note that the strategy was premised on the tation of the program. notion that initial private sector successes The limitations of this strategy quickly be- would empower the winners to push for fur- came apparent. It offered nothing to the large ther economic reforms and improved gover- khalid mohammed/ap/corbis

© numbers of Iraqis lacking either marketable nance, so that the growth process would take

Second Quarter 2013 33 expeditionary economics pying forces, it might have been sustainable, on a momentum of its own. But there was no and Iraq’s prospects would not have been so Plan B. What’s more, the vacuum created by grim in the wake of the U.S. withdrawal. the government’s pullback from day-to-day economic activity was filled by organized re- can afghanistan be saved? ligious and criminal groups whose interests Back to the conflict in the forefront of current hardly coincided with the commonweal. discussions of expeditionary economics. Over Even after the violence in Iraq was largely the last decade, the influx of military con- suppressed, organized crime abetted by per- tracting and development projects has fueled vasive government corruption (Iraq ranks rapid expansion in the Afghan economy. Al- near the bottom at 175th on Transparency In- though still near the bottom on almost all de- ternational’s 183-country Corruption Percep- velopment indicators, GDP (measured in tion Index, just behind Haiti) stifled entrepre- terms of purchasing power) roughly tripled neurial activity and undermined public trust between 2003 and 2011. in government institutions. Such trust in, This growth, however, does not herald the among other things, the enforceability of con- rise of a viable Afghan economy. The capacity tracts and property rights, is critical to effi- (and maybe the inclination) of the govern- ciency in market systems. Thus today, entre- ment to deliver basic services remains severely preneurship succeeds only at the sectarian limited, and government presence in remote level, where high levels of trust remain. areas is sketchy at best. Illegal activity contin- Advocates of expeditionary economics ues to thrive, further undermining the central have noted the folly of top-down economic government’s tenuous authority and influence. planning in countries with little means of im- Opium-poppy production remains by far the plementing it. The Iraq strategy focused on most dynamic economic activity, generating long-term goals with little regard for the task vast profits that are too often used to finance of getting from here to there – in particular, the Taliban insurgency. the challenge of giving large numbers of peo- Indeed, 10 years after the overthrow of the ple a stake in its success, early in the process. Taliban government, the World Bank esti- Government ministries, excluded from mates that the international military presence planning, were ill-prepared to assume author- and donor contributions account for more ity after the withdrawal of U.S. forces. Many than 97 percent – that’s right, 97 percent – of projects are simply rusting away because the Afghanistan’s legal GDP. Despite attempts to Iraqi bureaucracy has refused to accept respon- promote manufacturing and other industry, sibility for ongoing management and mainte- subsistence farming remains the mainstay of nance costs. The resulting waste of aid and re- the indigenous economy. Adding to Afghani- construction resources has been staggering. stan’s woes, the flood of international aid and A major lesson here is the wisdom of mini- military contracts has fueled inflation and mizing conflict with the existing culture. With created a real estate bubble. Housing in little social capital to lean on, entrepreneurial suburban Kabul rivaled those of European activity in Iraq has the greatest chance of capitals before air started leaking from the thriving at the local level. If a bottom-up strat- bubble last fall. egy stressing community-based development The coalition’s withdrawal in 2014 will had been adopted and nurtured by the occu- likely trigger a rapid decrease in foreigners’

34 The Milken Institute Review spending, and a commensurate collapse in real tivity is compatible with ongoing conflict – estate. Wealthy Afghans are already buying up albeit in somewhat distorted fashion. And property in Dubai at a record pace. Even the field work in Afghanistan sponsored by the World Bank, which tends to err on the side of Kauffman Foundation suggests that, despite understatement, concedes that economic government and donor neglect of Afghani- growth could turn sharply negative. That stan’s private sector, it has tremendous poten- would destroy a lot of jobs created in the last tial for generating employment. decade, most significantly for young men employed by private security com- panies. They might well turn to the Tali- ban, organized crime or regional mili- tias for income. Researchers at Tufts University have concluded that much of the blame for this precarious situation lies in the way that Western foreign aid has been man- aged. Rather than generating good will, development projects are viewed nega- tively by most Afghans. At the very least, the widespread sense that aid resources are being misused further tarnishes the image of the Afghan government; at worst, it shifts the blame for the utter failure of the Afghan state from Kabul to Western aid agencies. Aid failure in Afghanistan can be traced to the faulty premise that im- proved socioeconomic conditions would stabilize and pacify the country. In truth, rapid growth has been desta- bilizing since it raised the stakes in the competition for power and resources among the country’s regional militias and ethnic factions. Lack of coordination on Long-held stereotypes about entrepre- the part of the major donors, combined with neurs in conflict settings were found to be the narrow focus of most assistance programs, dead wrong. Indeed, based on some 130 in- has further hindered attempts to build the in- terviews, Jake Cusack and Erik Malmstrom stitutions of governance that are prerequisites (U.S. military combat veterans in Iraq and Af- to sustainable growth. ghanistan who went on earn graduate de- But what looks hopeless through a con- grees at Harvard) concluded that Afghan ventional lens seems very different from the businesses respond rationally to incentives – perspective of Carl Schramm and company. and that uncertainty, not physical insecurity, louis louis quail/in pictures/corbis

© They are convinced that entrepreneurial ac- is the fundamental obstacle to growth.

Second Quarter 2013 35 expeditionary economics purchased by NATO. Corruption is every- The Afghan government is part of the where, undermining critical institutions like problem, not the solution. It fails to provide those needed to enforce contracts and raising basic services, yet demands fealty and bribes the cost of doing business. It’s no wonder, that raise the cost of doing business – in par- then, that Afghanistan ranks a dismal 160th ticular, the cost of starting a business with lit- on the World Bank’s Ease of Doing Business tle capital. And both military contracting and Index (down six places in 2012, and behind foreign aid exacerbate the problem by giving such exemplars of free enterprise as Equato- the government more leverage over access to rial Guinea, Burkina Faso and Ukraine). Sim- jobs, capital and markets. Businesses survive ply registering a change in ownership of prop- by focusing on trading rather than long-term erty takes an average of 250 days. It’s very late in the game to apply an expedi- he Afghan government fails tionary-economics-based strategy to Afghani- T stan. But the United States is committed to to provide basic services, providing more aid; at the very least, a consis- tent policy of bottom-up assistance to entre- yet demands bribes that raise preneurs would offer hope to some Afghans as the cost of starting a busi- well as provide a donor-learning experience that would be applicable to the next conflict. ness with little capital. the next time market relationships and by purchasing pro- Though one can hope that the United States tection from the relevant warlords. But the and its allies will avoid conflicts on the scale drag on productivity is daunting. and duration of Iraq or Afghanistan, many The one bright spot in the effort to stimu- themes common to those conflicts are likely late indigenous enterprise has been the coun- to re-emerge down the road. Countries will try’s recent bottom-up attempt at improving be confronted by the challenge of groups of governance and raising small-business pro- militants or criminals (or both) that find ductivity, using aid cash as an incentive. The sanctuary inside failed states. In the absence National Solidarity Program created commu- of strong governments to expel them, these nity development councils in most villages. groups often mobilize popular support and This allowed community groups to take the extend their control by assuming some of the lead in planning local infrastructure invest- functions of government, including the deliv- ments – schools, water pumps, irrigation sys- ery of services and suppression of violence. tems – that are 90 percent funded by aid. (A As a result of their experiences in Iraq and 10 percent match is required, so locals have Afghanistan, Western armed forces have come some skin in the game.) All told, roughly $1 to the realization that this setting does not billion has been spent in 29,000 villages. lend itself to a purely military solution. While But the National Solidarity Program has ground can be captured, it cannot be secured been the exception to the rule in a country and stabilized without the support of the that has pocketed at least $50 billion in eco- local population. Thus, to be successful, oper- nomic aid since the Americans arrived, along ations must include reconstruction as a key with countless billions in the form of services component.

36 The Milken Institute Review Specifically, the U.S. military was able to significant role, particularly in areas that are assist in both countries through the Com- currently out of the effective reach of the cen- mander’s Emergency Response Program, in tral government. which officers designed and implemented Pakistan has a professional military that local projects like building schools, roads and (with additional training) could assist in the other essential infrastructure. To jump-start establishment of new entrepreneurs. More- local , these programs could be over, the government’s New Growth Frame- easily extended to support local entrepre- work, a sophisticated economic plan (aspired neurs, providing them with seed money and to, if not always followed) is entirely consistent security. with this sort of grass-roots encouragement of Both the Iraqi and Afghan cases demon- enterprise. strate the vitality of entrepreneurship in situ- Since the Pakistani military is stretched ations previously thought to be infertile thin and cannot provide adequate security in ground for business start-ups. And they sup- every arena of conflict, fresh thinking would port the conviction that comprehensive eco- be needed to implement an expeditionary nomic governance reforms aren’t a prerequi- economic approach. One possibility: the cre- site for self-sustaining economic growth. ation of secured reconstruction zones along One major policy failure in both Iraq and the lines that were successful in Afghanistan Afghanistan was the lack of an effective exit and in Haiti (in the aftermath of the devastat- strategy. In both cases, the withdrawal of ing earthquake in 2010). forces left vacuums in which no significant In extreme situations, a more radical ap- groups had vested interests in carrying re- proach, like the establishment of self-support- forms through to completion. To the contrary, ing, self-governing zones similar to those those who have inherited power have incen- under consideration in Honduras might be tives to derail the reforms. needed. (Honduras plans to create “charter The analysis of Mancur Olson, a promi- cities” – what amount to greenfield cities – nent American scholar in the development of that provide security, infrastructure and fi- what is called public-choice economics, helps nancing for new businesses.) in assaying the role of entrepreneurs in this context. Olson distinguished between “distri- * * * butional” coalitions, whose actions tend to Entrepreneurial economics as an alterna- undermine economic growth by protecting tive to traditional aid-based strategies is gain- their own privileges, and “encompassing” ing currency. Recent research by Raymond ones, whose interests align with broader soci- Gilpin of the U.S. Institute of Peace and Gayle etal goals. Clearly, local communities must Lemmon of the Council on Foreign Relations provide sufficient checks to prevent the emer- has documented the viability of job-creating gence of distributional coalitions. entrepreneurship in fragile settings. More- Looking ahead, there are likely to be situa- over, “fragile” applies to circumstances short tions in which countries – think of Pakistan – of war, like post-earthquake Haiti or even attempting to stem violence or quell insur- post-tsunami Japan, where the government gencies, or both, are nonetheless unwilling to has created special tax and regulation zones accept the presence of foreign military force. designed to attract entrepreneurs. The les- Here, expeditionary economics could play a sons here are well worth another look. m

Second Quarter 2013 37